As our economy becomes increasingly digitized, more transactions are moving online and outside of local tax jurisdictions, costing states billions in lost sales tax revenue. The recent U.S. Supreme Court decision in South Dakota v. Wayfair has opened the door for states to collect sales tax on online purchases made at out-of-state businesses. Applying state taxes on interstate commerce could not only recover lost revenues, but also make national e-commerce companies more invested in state government. Going forward, these companies will have the opportunity to make the case to lawmakers and voters on local sales taxes.

On June 21, the U.S. Supreme Court removed one of the largest advantages that e-commerce sites have in their competition with brick-and-mortar stores. The 5-4 decision in South Dakota v. Wayfair overturns the Supreme Court’s 1996 decision in Quill v. North Dakota that forced catalog companies to collect sales tax in states where they had a physical presence. This precedent had governed e-commerce sites for over two decades, during which time e-commerce has taken off. Subscriptions for Amazon Prime, a two-day delivery service, will have grown from 23 percent of American households in 2015 to an estimated 51 percent of households by the end of 2018. The boon for e-commerce companies, however, has cost state governments tax revenue. The Government Accountability Office estimates that states have lost as much as $13 billion in sales taxes in 2017 alone.

The majority opinion contrasted the physical presence requirement set out in the Quill decision with the broader “substantial nexus” standard on which it was based. The South Dakota tax, which only applies to businesses that make over 200 transactions or $100,000 in sales in the state annually, was deemed to have met the substantial nexus requirement. Under Quill, customers were expected to calculate sales tax and send those taxes to their state, but compliance was predictably low. The South Dakota decision compels online businesses to collect state taxes just as a brick-and-mortar store would. The dissenting opinion in the case argued that Congress has the ultimate authority over interstate commerce and is better suited to determine taxation powers for states.

Sell anywhere, tax anywhere

The internet dramatically expands the geographic reach of any business to anyone in the United States with internet access, a bank account, and a physical address. This allows e-commerce companies to locate strategically to minimize shipping distances and employ talented workforces. A company may establish a physical presence in only a handful of states and cities while serving the entire country. Meanwhile, brick-and-mortar businesses serving local markets struggle to compete against national e-commerce companies. State and local governments lose not only sales tax revenue from out-of-state purchases, but also property and payroll taxes from closing local businesses.

The South Dakota ruling will surely extend online sales taxes to more states. Calculating, collecting, and remitting taxes to each state could complicate e-commerce businesses’ operations, but a shipping address already contains the relevant information for assessing local taxes. Although small vendors may have a harder time collecting local taxes, they likely also fall underneath the thresholds set by states to qualify as having a “substantial nexus.” Sellers already use third-party e-commerce platforms like e-Bay, Etsy, and Amazon Marketplace to reach more customers and fulfill orders; similar tools could also simplify sending sales tax to states.

E-commerce companies might respond in a number of ways. They may choose to set up shop in more states to qualify for better tax rates, bringing jobs with them. Another strategy, pioneered by transportation network companies like Uber, is to mobilize customers to voice their opinions on local regulations. When e-commerce sites begin collecting taxes in more states, they may want a say on future sales tax increases or on how sales taxes are spent. Regardless of where companies locate, they will soon have a financial stake in every state where they do businesses. E-commerce companies will have to focus on the states even as they sell their goods nationally.

Miku Fujita contributed research to this blog post.

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By Jack Karsten, Darrell M. West
As our economy becomes increasingly digitized, more transactions are moving online and outside of local tax jurisdictions, costing states billions in lost sales tax revenue. The recent U.S. Supreme Court decision in South Dakota v. Wayfair has opened the door for states to collect sales tax on online purchases made at out-of-state businesses. Applying state taxes on interstate commerce could not only recover lost revenues, but also make national e-commerce companies more invested in state government. Going forward, these companies will have the opportunity to make the case to lawmakers and voters on local sales taxes.
On June 21, the U.S. Supreme Court removed one of the largest advantages that e-commerce sites have in their competition with brick-and-mortar stores. The 5-4 decision in South Dakota v. Wayfair overturns the Supreme Court’s 1996 decision in Quill v. North Dakota that forced catalog companies to collect sales tax in states where they had a physical presence. This precedent had governed e-commerce sites for over two decades, during which time e-commerce has taken off. Subscriptions for Amazon Prime, a two-day delivery service, will have grown from 23 percent of American households in 2015 to an estimated 51 percent of households by the end of 2018. The boon for e-commerce companies, however, has cost state governments tax revenue. The Government Accountability Office estimates that states have lost as much as $13 billion in sales taxes in 2017 alone.
The majority opinion contrasted the physical presence requirement set out in the Quill decision with the broader “substantial nexus” standard on which it was based. The South Dakota tax, which only applies to businesses that make over 200 transactions or $100,000 in sales in the state annually, was deemed to have met the substantial nexus requirement. Under Quill, customers were expected to calculate sales tax and send those taxes to their state, but compliance was predictably low. The South Dakota decision compels online businesses to collect state taxes just as a brick-and-mortar store would. The dissenting opinion in the case argued that Congress has the ultimate authority over interstate commerce and is better suited to determine taxation powers for states.
Sell anywhere, tax anywhere
The internet dramatically expands the geographic reach of any business to anyone in the United States with internet access, a bank account, and a physical address. This allows e-commerce companies to locate strategically to minimize shipping distances and employ talented workforces. A company may establish a physical presence in only a handful of states and cities while serving the entire country. Meanwhile, brick-and-mortar businesses serving local markets struggle to compete against national e-commerce companies. State and local governments lose not only sales tax revenue from out-of-state purchases, but also property and payroll taxes from closing local businesses.
The South Dakota ruling will surely extend online sales taxes to more states. Calculating, collecting, and remitting taxes to each state could complicate e-commerce businesses’ operations, but a shipping address already contains the relevant information for assessing local taxes. Although small vendors may have a harder time collecting local taxes, they likely also fall underneath the thresholds set by states to qualify as having a “substantial nexus.” Sellers already use third-party e-commerce platforms like e-Bay, Etsy, and Amazon Marketplace to reach more customers and fulfill orders; similar tools could also simplify sending sales tax to states.
E-commerce companies might respond in a number of ways. They may choose to set up shop in more states to qualify for better tax rates, bringing jobs with them. Another strategy, pioneered by transportation network companies like Uber, is to mobilize customers to voice their opinions on ... By Jack Karsten, Darrell M. West
As our economy becomes increasingly digitized, more transactions are moving online and outside of local tax jurisdictions, costing states billions in lost sales tax revenue. The recent U.https://www.brookings.edu/interactives/hutchins-center-fiscal-impact-measure/Hutchins Center Fiscal Impact Measurehttp://webfeeds.brookings.edu/~/275899806/0/brookingsrss/topics/taxes~Hutchins-Center-Fiscal-Impact-Measure/
Fri, 27 Jul 2018 14:00:15 +0000https://www.brookings.edu/?post_type=interactive&p=364199

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By Eric Abalahin

The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and spending at the federal, state and local levels. (Methodology »)

TAKEAWAYS FROM THE SECOND QUARTER UPDATE, 07/27/18

By Louise Sheiner and Sage Belz

According to the latest reading from the Hutchins’ Fiscal Impact Measure, federal, state and local fiscal policies added to the pace of economic growth in the second quarter. Fiscal policy at all levels of government contributed 0.6 percentage points to GDP growth in the second quarter, its highest contribution in over two years. Overall GDP rose at an inflation-adjusted annual rate of 4.1 percent.

The FIM now sits above what we estimate to be neutral—that is, the level at which fiscal policy’s contribution to GDP is in line with potential real GDP growth. While we expect the FIM to be positive, on average, the most recent reading suggests federal policies are providing additional stimulus to the economy beyond what is consistent with trend growth.

During the Great Recession, fiscal policy added significantly to economic growth. But in 2011, the FIM fell below zero for almost four years, indicating that fiscal policy subtracted from economic growth. Over the last eight quarters, however, the FIM has rebounded and hovered above zero.

In the second quarter, federal spending increased at an annual rate of 3½ percent, in large part because of higher defense spending. State and local spending rose about 1½ percent in the second quarter, continuing the pattern of sluggish grown observed in recent years. Real state and local construction has grown by less than 5 percent since 2016, and remains 25 percent lower than its level in 2008. Employment in the sector has registered almost zero growth in the last year, and continues to sit below its pre-recession levels. Historically, state and local expenditures make up a bigger part of the economy (11 percent on average) than federal spending (about 7 percent on average).

Tax and transfer policies had a positive effect on GDP growth in the second quarter. Spending on the federal government’s three largest benefit programs—Social Security, Medicare and Medicaid—continue to increase at a moderate pace, while taxes on personal income have declined since the enactment of new tax legislation at the start of the year. The FIM reflects the gradual translation of lower taxes into spending and GDP growth.

The comprehensive revisions to the national accounts released with the second quarter GDP estimates had little effect on previous values of the FIM.

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By Eric Abalahin
The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and spending at the federal, state and local levels. (Methodology »)
TAKEAWAYS FROM THE SECOND QUARTER UPDATE, 07/27/18
By Louise Sheiner and Sage Belz
According to the latest reading from the Hutchins’ Fiscal Impact Measure, federal, state and local fiscal policies added to the pace of economic growth in the second quarter. Fiscal policy at all levels of government contributed 0.6 percentage points to GDP growth in the second quarter, its highest contribution in over two years. Overall GDP rose at an inflation-adjusted annual rate of 4.1 percent.
The FIM now sits above what we estimate to be neutral—that is, the level at which fiscal policy’s contribution to GDP is in line with potential real GDP growth. While we expect the FIM to be positive, on average, the most recent reading suggests federal policies are providing additional stimulus to the economy beyond what is consistent with trend growth.
During the Great Recession, fiscal policy added significantly to economic growth. But in 2011, the FIM fell below zero for almost four years, indicating that fiscal policy subtracted from economic growth. Over the last eight quarters, however, the FIM has rebounded and hovered above zero.
In the second quarter, federal spending increased at an annual rate of 3½ percent, in large part because of higher defense spending. State and local spending rose about 1½ percent in the second quarter, continuing the pattern of sluggish grown observed in recent years. Real state and local construction has grown by less than 5 percent since 2016, and remains 25 percent lower than its level in 2008. Employment in the sector has registered almost zero growth in the last year, and continues to sit below its pre-recession levels. Historically, state and local expenditures make up a bigger part of the economy (11 percent on average) than federal spending (about 7 percent on average).
Tax and transfer policies had a positive effect on GDP growth in the second quarter. Spending on the federal government’s three largest benefit programs—Social Security, Medicare and Medicaid—continue to increase at a moderate pace, while taxes on personal income have declined since the enactment of new tax legislation at the start of the year. The FIM reflects the gradual translation of lower taxes into spending and GDP growth.
The comprehensive revisions to the national accounts released with the second quarter GDP estimates had little effect on previous values of the FIM.
By Eric Abalahin
The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and ... https://www.brookings.edu/research/making-border-carbon-adjustments-work-in-law-and-practice/Making border carbon adjustments work in law and practicehttp://webfeeds.brookings.edu/~/560937066/0/brookingsrss/topics/taxes~Making-border-carbon-adjustments-work-in-law-and-practice/
Mon, 30 Nov -0001 00:00:00 +0000https://www.brookings.edu/?post_type=research&p=530184

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By Adele Morris

Some U.S. firms use proportionately more energy than other firms do, and they compete in international markets. These firms and their products are called energy-intensive and trade-exposed (EITE). All else equal, a greenhouse gas (GHG) tax (a carbon tax, for short) imposed in the United States and not analogously in other countries could lower the tax’s environmental benefits by driving production, new investment, and emissions to countries with less ambitious climate policy, a shift known as emissions leakage.

Draft U.S. carbon tax bills and other proposals manage this with border carbon adjustments (BCAs). An import BCA would apply a charge to select imported emissions-intensive goods. An export BCA would pay domestic producers for the carbon tax-related costs they incur in making goods they export from the United States.

In the policy brief “Making border carbon adjustments work in law and practice” (PDF), Adele Morris addresses issues relating to the creation of border carbon adjustments (BCAs) as part of a carbon tax. To which products should BCAs apply, and from what countries and on what basis? Under what conditions could or should BCAs be suspended, and who decides? Which responsibilities should fall to which agencies, and how might stakeholders appeal determinations made by federal agencies? What kind of emissions or economic data would BCA administrators need, and how can the program remain simple enough to administer feasibly? What constraints do World Trade Organization (WTO) rules impose on the design of a BCA program? And what would be the implications if other countries applied similar measures to U.S. goods?

Why include BCAs in a carbon tax bill?

At least three potential motives apply to BCAs: reducing emissions leakage; preserving the competitiveness of U.S. manufacturers; and pressuring trading partners with less stringent climate policies to catch up.1 However, in light of research revealing relatively small amounts of leakage as summarized by Aldy (2017), the primary goal of BCAs should be to address the concerns of the most vulnerable industries without worrying too much about emissions leakage more broadly.

What should a BCA adjust, exactly?

Intuitively, an export BCA would compensate domestic producers that export their goods for the increase in their costs of production that result from the carbon tax. An import BCA would charge importers for the carbon emitted in the production of the products they sell in the United States. In practice, a BCA program can only adjust what administrators can observe, measure, and monetize.

What policymakers choose to adjust significantly affects the incentives of firms. Suppose the export BCA adjusts only for direct and indirect carbon tax liabilities embodied in the exported product. Then a firm’s export rebate could shrink when it lowers its emissions, undermining incentives to abate. Likewise firms using a range of production processes would have the incentive to export their most carbon-intensive products. The policy could set the border adjustment based on embodied emissions for all production of a given product by a particular firm, not just exports. That would limit the returns to export shuffling, but could involve tracking tax burdens for far more goods than those that end up exported. It could also induce firms to spin off their higher emissions production into a separate export-intensive firm.

Policymakers could peg export BCAs to measures like current or historical U.S. industry averages, rather than firm-level behavior. Such benchmarks would simplify program administration, but then BCAs would diverge from firms’ actual costs; some would be overcompensated and some undercompensated.

Similar challenges arise in setting import BCAs with the added problem of measuring the emissions in other countries attributable to the products they send into the United States. The import BCA could price the carbon in the firm’s production process at the applicable carbon tax rate in the United States.2 This approach would require considerable information about the production process, but it would reasonably mirror the tax applicable to comparable production in the United States. Of course, another country could shuffle which goods go to export, steering its cleanest products to the United States (or wherever has the lowest import BCA). This could justify using a firm-level average for emissions attributable to production of all of a given product.

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By Adele Morris
Some U.S. firms use proportionately more energy than other firms do, and they compete in international markets. These firms and their products are called energy-intensive and trade-exposed (EITE). All else equal, a greenhouse gas (GHG) tax (a carbon tax, for short) imposed in the United States and not analogously in other countries could lower the tax’s environmental benefits by driving production, new investment, and emissions to countries with less ambitious climate policy, a shift known as emissions leakage.
Draft U.S. carbon tax bills and other proposals manage this with border carbon adjustments (BCAs). An import BCA would apply a charge to select imported emissions-intensive goods. An export BCA would pay domestic producers for the carbon tax-related costs they incur in making goods they export from the United States.
In the policy brief “Making border carbon adjustments work in law and practice” (PDF), Adele Morris addresses issues relating to the creation of border carbon adjustments (BCAs) as part of a carbon tax. To which products should BCAs apply, and from what countries and on what basis? Under what conditions could or should BCAs be suspended, and who decides? Which responsibilities should fall to which agencies, and how might stakeholders appeal determinations made by federal agencies? What kind of emissions or economic data would BCA administrators need, and how can the program remain simple enough to administer feasibly? What constraints do World Trade Organization (WTO) rules impose on the design of a BCA program? And what would be the implications if other countries applied similar measures to U.S. goods?
Why include BCAs in a carbon tax bill?
At least three potential motives apply to BCAs: reducing emissions leakage; preserving the competitiveness of U.S. manufacturers; and pressuring trading partners with less stringent climate policies to catch up.1 However, in light of research revealing relatively small amounts of leakage as summarized by Aldy (2017), the primary goal of BCAs should be to address the concerns of the most vulnerable industries without worrying too much about emissions leakage more broadly.
What should a BCA adjust, exactly?
Intuitively, an export BCA would compensate domestic producers that export their goods for the increase in their costs of production that result from the carbon tax. An import BCA would charge importers for the carbon emitted in the production of the products they sell in the United States. In practice, a BCA program can only adjust what administrators can observe, measure, and monetize.
What policymakers choose to adjust significantly affects the incentives of firms. Suppose the export BCA adjusts only for direct and indirect carbon tax liabilities embodied in the exported product. Then a firm’s export rebate could shrink when it lowers its emissions, undermining incentives to abate. Likewise firms using a range of production processes would have the incentive to export their most carbon-intensive products. The policy could set the border adjustment based on embodied emissions for all production of a given product by a particular firm, not just exports. That would limit the returns to export shuffling, but could involve tracking tax burdens for far more goods than those that end up exported. It could also induce firms to spin off their higher emissions production into a separate export-intensive firm.
Policymakers could peg export BCAs to measures like current or historical U.S. industry averages, rather than firm-level behavior. Such benchmarks would simplify program administration, but then BCAs would diverge from firms’ actual costs; some would be overcompensated and some undercompensated.
Similar challenges arise in setting import BCAs with the added problem of measuring the emissions in other countries attributable to the products they send into the United States. The import BCA ... By Adele Morris
Some U.S. firms use proportionately more energy than other firms do, and they compete in international markets. These firms and their products are called energy-intensive and trade-exposed (EITE). All else equal, a greenhouse gas ... https://www.brookings.edu/blog/up-front/2018/07/23/tax-exemption-offsets-lack-of-competition-in-municipal-bond-markets/Tax exemption offsets lack of competition in municipal bond marketshttp://webfeeds.brookings.edu/~/560306218/0/brookingsrss/topics/taxes~Tax-exemption-offsets-lack-of-competition-in-municipal-bond-markets/
Mon, 23 Jul 2018 14:20:48 +0000https://www.brookings.edu/?p=529414

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By Sage Belz, Louise Sheiner

The tax exemption for earnings on municipal bonds cost the federal government almost $31 billion in 2017. The exemption is intended to promote state and local investment, but many analysts argue the policy is an inefficient way to provide such a subsidy.

How is it that the tax benefit has such a large impact on state and local borrowing costs? Suárez Serrato and coauthors say lack of competition in muni bond auctions—which often include few participants who need specialized information about each municipality and bond issuance—allows powerful bidders to suppress the price of the bond below what they would be willing to pay in a competitive auction. When a tax increase raises the value of the tax exemption, additional investors join the auction and bid higher prices. The tax hike not only raises the price investors are privately willing to pay, but also makes the auction more competitive. As evidence for this hypothesis, the authors show the pass through from tax savings to borrowing costs is larger for bonds issued by school districts and smaller jurisdictions, where auctions tend to have very few bidders and often are private.

[T]ax exemption is an effective policy for subsidizing state and local governments, and that its removal could place substantial burden on municipalities.

What does this mean for the importance of muni bond tax exemptions? The Suárez Serrato analysis implies the tax exemption is an effective policy for subsidizing state and local governments, and that its removal could place substantial burden on municipalities. In an analysis of the effects of the recently enacted Tax Cuts and Jobs Act, the authors find the new law—which limits the deductibility of state and local taxes and hence raises the effective tax rate—may lower interest costs for municipalities by 2.5 percent. An Obama-era proposal to limit the deductibility of muni interest income, on the other hand, would lead to an increase in state and local borrowing costs of around 31 percent, on average.

Suárez Serrato and coauthors note that these large policy effects exist primarily because of inefficiencies in primary municipal bond markets. If the tax advantages turn into public savings because bond auctions tend to be uncompetitive, then policies aimed at increasing competition in municipal bond auctions could significantly lower borrowing costs without sending the bill to federal and state taxpayers.

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By Sage Belz, Louise Sheiner
The tax exemption for earnings on municipal bonds cost the federal government almost $31 billion in 2017. The exemption is intended to promote state and local investment, but many analysts argue the policy is an inefficient way to provide such a subsidy.
In a paper presented at the 2018 Municipal Finance Conference at Brookings, Duke University economists Juan Carlos Suárez Serrato, James W. Roberts, Andrey Ordin, and Daniel Garrett show that each dollar of tax exemption for interest paid on municipal bonds generates about $1.80 in savings for municipal authorities. In the paper “Tax Advantages and Imperfect Competition in Auctions for Municipal Bonds,” using data on submitted and winning bids at municipal bond auctions, the authors estimate that each percentage point increase in the effective personal income tax rate on taxable bonds reduces municipal borrowing costs by roughly 9 percent, implying state and local governments receive a significant subsidy via the tax exemption.
How is it that the tax benefit has such a large impact on state and local borrowing costs? Suárez Serrato and coauthors say lack of competition in muni bond auctions—which often include few participants who need specialized information about each municipality and bond issuance—allows powerful bidders to suppress the price of the bond below what they would be willing to pay in a competitive auction. When a tax increase raises the value of the tax exemption, additional investors join the auction and bid higher prices. The tax hike not only raises the price investors are privately willing to pay, but also makes the auction more competitive. As evidence for this hypothesis, the authors show the pass through from tax savings to borrowing costs is larger for bonds issued by school districts and smaller jurisdictions, where auctions tend to have very few bidders and often are private.
[T]ax exemption is an effective policy for subsidizing state and local governments, and that its removal could place substantial burden on municipalities.
What does this mean for the importance of muni bond tax exemptions? The Suárez Serrato analysis implies the tax exemption is an effective policy for subsidizing state and local governments, and that its removal could place substantial burden on municipalities. In an analysis of the effects of the recently enacted Tax Cuts and Jobs Act, the authors find the new law—which limits the deductibility of state and local taxes and hence raises the effective tax rate—may lower interest costs for municipalities by 2.5 percent. An Obama-era proposal to limit the deductibility of muni interest income, on the other hand, would lead to an increase in state and local borrowing costs of around 31 percent, on average.
Suárez Serrato and coauthors note that these large policy effects exist primarily because of inefficiencies in primary municipal bond markets. If the tax advantages turn into public savings because bond auctions tend to be uncompetitive, then policies aimed at increasing competition in municipal bond auctions could significantly lower borrowing costs without sending the bill to federal and state taxpayers.By Sage Belz, Louise Sheiner
The tax exemption for earnings on municipal bonds cost the federal government almost $31 billion in 2017. The exemption is intended to promote state and local investment, but many analysts argue the policy is an ... https://www.brookings.edu/research/effects-of-the-tax-cuts-and-jobs-act-a-preliminary-analysis/Effects of the Tax Cuts and Jobs Act: A preliminary analysishttp://webfeeds.brookings.edu/~/552185276/0/brookingsrss/topics/taxes~Effects-of-the-Tax-Cuts-and-Jobs-Act-A-preliminary-analysis/
Thu, 14 Jun 2018 16:10:30 +0000https://www.brookings.edu/?post_type=research&p=522477

On December 22, 2017, Donald Trump signed into law the biggest tax overhaul since the Tax Reform Act of 1986. The new tax law makes substantial changes to the rates and bases of both the individual and corporate income taxes, most prominently cutting the maximum corporate income tax rate to 21 percent, redesigning international tax rules, and providing a deduction for pass-through income.

Other major changes include expensing of equipment investment; elimination of personal and dependent exemptions, the tax on people who do not obtain adequate health insurance coverage, and the corporate alternative minimum tax; and increases in the standard deduction, the estate tax exemption, and the individual alternative minimum tax exemption.

They find that TCJA will stimulate the economy in the near term, but the long-term impact on gross domestic product (GDP) will be small. The impact will be smaller on gross national product (GNP) than on GDP because the law will generate net capital inflows from abroad that have to be repaid in the future.

The new law will reduce federal revenues by significant amounts, even after allowing for the impact on economic growth. It will make the distribution of after-tax income more unequal. If it is not financed with concurrent spending cuts or other tax increases, TCJA will raise federal debt and impose burdens on future generations. If it is financed with spending cuts or other tax increases, TCJA will, under the most plausible scenarios, end up making most households worse off than if it had not been enacted.

The new law simplifies taxes in some ways but creates new complexity and compliance issues in others. It will raise health care premiums and reduce health insurance coverage. It will affect activities in many sectors, including state and local public spending, charitable organizations, and housing.

The authors conclude that the new law leaves many unanswered questions. It phases out many provisions over time, and it leaves US revenues significantly below what is needed to address long-term fiscal shortfalls. These aspects invite reconsideration of the tax policy choices made in the TCJA over the next several years.

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By William G. Gale, Hilary Gelfond, Aaron Krupkin, Mark Mazur, Eric Toder
On December 22, 2017, Donald Trump signed into law the biggest tax overhaul since the Tax Reform Act of 1986. The new tax law makes substantial changes to the rates and bases of both the individual and corporate income taxes, most prominently cutting the maximum corporate income tax rate to 21 percent, redesigning international tax rules, and providing a deduction for pass-through income.
Other major changes include expensing of equipment investment; elimination of personal and dependent exemptions, the tax on people who do not obtain adequate health insurance coverage, and the corporate alternative minimum tax; and increases in the standard deduction, the estate tax exemption, and the individual alternative minimum tax exemption.
In “Effects of the Tax Cuts and Jobs Act: A preliminary analysis” (PDF), William Gale, Hilary Gelfond, Aaron Krupkin, Mark J. Mazur, and Eric Toder summarize the provisions of the bill and provide preliminary analysis of their effects.
They find that TCJA will stimulate the economy in the near term, but the long-term impact on gross domestic product (GDP) will be small. The impact will be smaller on gross national product (GNP) than on GDP because the law will generate net capital inflows from abroad that have to be repaid in the future.
The new law will reduce federal revenues by significant amounts, even after allowing for the impact on economic growth. It will make the distribution of after-tax income more unequal. If it is not financed with concurrent spending cuts or other tax increases, TCJA will raise federal debt and impose burdens on future generations. If it is financed with spending cuts or other tax increases, TCJA will, under the most plausible scenarios, end up making most households worse off than if it had not been enacted.
The new law simplifies taxes in some ways but creates new complexity and compliance issues in others. It will raise health care premiums and reduce health insurance coverage. It will affect activities in many sectors, including state and local public spending, charitable organizations, and housing.
The authors conclude that the new law leaves many unanswered questions. It phases out many provisions over time, and it leaves US revenues significantly below what is needed to address long-term fiscal shortfalls. These aspects invite reconsideration of the tax policy choices made in the TCJA over the next several years.
Read the full report here. By William G. Gale, Hilary Gelfond, Aaron Krupkin, Mark Mazur, Eric Toder
On December 22, 2017, Donald Trump signed into law the biggest tax overhaul since the Tax Reform Act of 1986. The new tax law makes substantial changes to the rates and ... https://www.brookings.edu/research/yes-there-really-is-a-tax-break-for-upper-income-graduate-students-and-congress-wont-let-it-expire/Yes, there really is a tax break for upper-income graduate students and Congress won’t let it expirehttp://webfeeds.brookings.edu/~/549183556/0/brookingsrss/topics/taxes~Yes-there-really-is-a-tax-break-for-upperincome-graduate-students-and-Congress-wont-let-it-expire/
Thu, 31 May 2018 09:00:07 +0000https://www.brookings.edu/?post_type=research&p=519271

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By Jason Delisle

In an earlier Evidence Speaks post this year, Susan Dynarski and Judith Scott-Clayton summarized important research showing that federal tax benefits for college tuition have had no measurable impact on increasing college-going behavior.1 Moreover, they note that the benefits are numerous, overlapping and complicated. Yet for all their flaws, these tax breaks enjoy such strong support from lawmakers that even the oddest one, which quietly expires each year, is always revived in a last-minute bill just in time for the tax filing season. The tuition and fees deduction (“the deduction”) was recently extended for a seventh time in an omnibus budget bill in February.2 Out of all the tuition tax benefits the government offers, this one should be relatively easy to let go because of whom it unintentionally targets.

Here is how the deduction works. Tax filers can deduct up to $4,000 of tuition and fees paid for higher education in the tax year. It is an “above-the-line” deduction, meaning filers can claim it without having to itemize deductions. As a deduction, filers earn a benefit equal to their marginal tax rate. The maximum benefit any filer could extract from the deduction is $880, the top marginal tax rate of those who are eligible (22 percent) times $4,000. There is no limit to the number of times a filer can claim the deduction, so long as he has incurred tuition expenses, and it does not matter what type of credential he pursues. There is, however, an income limit. Taxpayers with adjusted gross incomes above $80,000 ($160,000 for joint filers) cannot claim it.

There is nothing odd about those terms per se, but they interact with other tax benefits the government offers for tuition such that only upper-income graduate students benefit from the deduction. First, undergraduates, while eligible for the deduction, don’t claim it because a different tax credit only for undergraduates is more beneficial: the American Opportunity Tax Credit, which is worth up to $2,500 in tax relief for filers earning up to $90,000 ($180,000 for joint filers).3 Tax filers can claim only one tuition tax benefit although they usually qualify for more than one. Second, graduate students with lower and middle incomes are also eligible for the deduction, but they can claim the $2,000 Lifetime Learning Credit, which almost always delivers a bigger tax break than the tuition and fees deduction.4 But the Lifetime Learning credit has a lower income cut-off than the deduction. Those earning over $66,000 ($132,000 for joint filers) in 2017 cannot claim it.5

That’s how the deduction ends up targeting upper-income graduate students. While graduate students would always obtain a larger benefit from the Lifetime Learning Credit, they cannot claim it if they earn more than $66,000 ($132,000 for joint filers). They can, however, claim the deduction until their earnings exceed $80,000 ($160,000 for joint filers). Thus a narrow band of graduate students, those earning between the income limits for the two benefits, are the only students who would claim the deduction. At those levels, their incomes are higher than the incomes of about 80 percent of U.S. households.6 Of course, tax filers can unintentionally claim a less generous benefit if they are eligible for more than one, such as an undergraduate claiming the deduction when she was eligible for the American Opportunity Tax Credit, which does happen.7

Table 1 – Provisions of the Three Tax Benefits for Higher Education

Tax Reduction

Income Limit (Adjusted Gross Income)

Eligibility

American Opportunity Tax Credit

Up to $2,500 (100% of first $2,000 in tuition and fees; 25% of next $2,000)

Full credit: up to $80,000 (single filers) or $160,000 (married filers)
Partial credit: up to $90,000 (single filers) or $180,000 (married filers)

Undergraduate students* enrolled at least half time (first four years only)

Lifetime Learning Tax Credit

Up to $2,000 (20% of first $10,000 in tuition and fees)

Full credit: up to $56,000 (single filers) or $112,000 (married filers)
Partial credit: up to $66,000 (single filers) or $132,000 (married filers)

All students

Tuition and Fees Deduction

Above-the-line deduction of first $4,000 in tuition and fees

Full deduction: up to $65,000 (single filers) or $130,000 (married filers)
Partial deduction: up to $80,000 (single filers) or $160,000 (married filers)

All students

Note: Students eligible for multiple benefits can claim only one benefit per year.

Source: Internal Revenue Service

*Students must be in their first four years of postsecondary education in order to claim the American Opportunity Tax Credit. While it is theoretically possible for a graduate student to claim the credit, in practice virtually all beneficiaries are undergraduates.

What the data say about eligible students

Using a representative sample of graduate students in 2011-12, Kim Dancy of New America and I estimated that just 8 percent of graduate students would benefit from the deduction. Meanwhile, 64 percent of graduate students would benefit most from the Lifetime Learning Credit. The rest of graduate students (28 percent) were ineligible for any tax benefit because they have no taxable income, their tuition was fully covered by grants and scholarships, or their earnings were too high.8 The analysis assumes that tax filers claim the benefit that provides them with the largest tax reduction if they qualify for more than one. These numbers have likely shifted in recent years, with even fewer students benefiting from the deduction, because Congress has increased the earnings cap for the Lifetime Learning Credit to account for inflation but left the limits for the deduction unchanged.

We also estimated the average benefit graduate students would claim through the deduction for the 2011-12 academic year. At $621, it was smaller than the $859 average benefit that filers eligible for the Lifetime Learning Credit could claim.9 Due to small sample sizes, however, we were unable to reliably assess important characteristics of filers eligible for the deduction, such as field of study.

The deduction didn’t start out as a graduate school tax break

As is often the case in public policy, lawmakers did not set out explicitly to provide a tax break to upper-income graduate students. In fact, graduate students were never the target group for the tuition tax breaks; undergraduates were always the focus. Although graduate students have been eligible for the tax benefits since their inception, changes to the policies over the years have left the deduction benefiting upper-income graduate students alone.

Prior to mid-1990s, the federal government did not offer widely-available tax breaks for college tuition. The idea first gained prominence when President Clinton proposed a $10,000 deduction for college tuition as part of his “Middle-Class Bill of Rights” reelection platform.10 After critics noted that a deduction would provide more help to families in higher tax brackets, Clinton added a separate tax credit for the first two years of college to his proposal to provide more even benefits.11 Congress adopted the president’s idea for the credit in 1997, naming it the Hope Tax Credit, but rejected the additional proposal for a $10,000 deduction. They instead replaced that proposal with a separate credit for “lifelong learning” (i.e., the Lifetime Learning Credit) that families could claim for education after the first two years of college, including graduate school.12

Thus, President Clinton’s original idea for a deduction and a credit was replaced with two credits, the Hope Tax Credit and the Lifetime Learning Tax Credit. In keeping with their original purpose to provide middle-class tax relief, Congress capped income eligibility for both benefits at $55,000 ($100,000 for joint filers) in 1997.13

With these two tax credits on the books, the idea of a deduction for tuition would be unnecessary and redundant, yet Congress later decided to add one anyway. Seemingly out of nowhere, lawmakers included a $4,000 deduction for tuition and fees in the Economic Growth and Tax Relief Reconciliation Act of 2001, the sweeping bill that included President Bush’s campaign proposal to cut marginal tax rates.14

The deduction differed from the two initial tax credits in a key way, which partially explains why lawmakers added it. Families earning up to $80,000 ($160,000 for joint filers) would be eligible as of 2004. That was significantly higher than the income cutoff for the Hope and Lifetime Learning Credits at the time and would therefore offer tax benefits to families with incomes arguably well above middle class. But why not just raise the income limits on the existing credits then? Because creating the new deduction was a way to restrict costs relative to expanding the existing Lifetime Learning Credit in terms of forgone revenue to the government. Recall that the value of the deduction is worth the amount deducted times the marginal tax rate, which at the time it was created would have been $1,120 at the most.15 That is about half the maximum value of the Lifetime Learning credit.16

In other words, the deduction was a way to let upper-income families into the college tax benefit club on the cheap. It also ensured their benefits would be smaller than those of the middle-class families, who were eligible for the credits.

At the time it was created, the deduction was as much an undergraduate benefit as a graduate one. Upper-income families would claim it for tuition paid in pursuit of either degree. According to my analysis referenced earlier, about the same share of graduate students as undergraduates qualified for it prior to 2009.17 But in 2009, Congress would make it pointless for almost any undergraduate to claim the deduction. That year, lawmakers replaced the Hope Credit with the American Opportunity Tax Credit, which provided larger benefits than the deduction with an income cutoff even higher than the deduction. With upper-income undergraduates now qualifying for American Opportunity Tax Credit, graduate students became the only group left who could benefit from the original tuition and fees deduction.

conclusion

While Congress never decided to directly create a special tax break for upper-income graduate students alone, opting to extend the deduction year after year is effectively the same thing. The latest one-year extension, which made the deduction available for the 2017 tax year, cost the government over $200 million in forgone revenue.18

At a time when an undergraduate education feels financially out of reach for so many families, it’s fair to ask why Congress continues to spend these resources on students who have already earned an undergraduate degree. Moreover, these students earn a median household income of $102,000, according to my analysis.19 There does not appear to be a good answer to that question other than inertia. Lawmakers have always extended the benefit so they continue to extend it. They may not realize, however, that it no longer benefits undergraduate students.

All of the tax benefits may be a policy failure for not increasing enrollment or being overly complex, but at least those for undergraduates put more money in the pockets of low- and middle-income families working toward their first degree. Today, the deduction does neither. It helps those who already have an undergraduate degree and earn high incomes to boot. While its cost in terms of forgone revenue are relatively modest, those resources would be better spent on aid that encourages students to enroll in and complete an undergraduate degree.

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By Jason Delisle
In an earlier Evidence Speaks post this year, Susan Dynarski and Judith Scott-Clayton summarized important research showing that federal tax benefits for college tuition have had no measurable impact on increasing college-going behavior.1 Moreover, they note that the benefits are numerous, overlapping and complicated. Yet for all their flaws, these tax breaks enjoy such strong support from lawmakers that even the oddest one, which quietly expires each year, is always revived in a last-minute bill just in time for the tax filing season. The tuition and fees deduction (“the deduction”) was recently extended for a seventh time in an omnibus budget bill in February.2 Out of all the tuition tax benefits the government offers, this one should be relatively easy to let go because of whom it unintentionally targets.
Here is how the deduction works. Tax filers can deduct up to $4,000 of tuition and fees paid for higher education in the tax year. It is an “above-the-line” deduction, meaning filers can claim it without having to itemize deductions. As a deduction, filers earn a benefit equal to their marginal tax rate. The maximum benefit any filer could extract from the deduction is $880, the top marginal tax rate of those who are eligible (22 percent) times $4,000. There is no limit to the number of times a filer can claim the deduction, so long as he has incurred tuition expenses, and it does not matter what type of credential he pursues. There is, however, an income limit. Taxpayers with adjusted gross incomes above $80,000 ($160,000 for joint filers) cannot claim it.
There is nothing odd about those terms per se, but they interact with other tax benefits the government offers for tuition such that only upper-income graduate students benefit from the deduction. First, undergraduates, while eligible for the deduction, don’t claim it because a different tax credit only for undergraduates is more beneficial: the American Opportunity Tax Credit, which is worth up to $2,500 in tax relief for filers earning up to $90,000 ($180,000 for joint filers).3 Tax filers can claim only one tuition tax benefit although they usually qualify for more than one. Second, graduate students with lower and middle incomes are also eligible for the deduction, but they can claim the $2,000 Lifetime Learning Credit, which almost always delivers a bigger tax break than the tuition and fees deduction.4 But the Lifetime Learning credit has a lower income cut-off than the deduction. Those earning over $66,000 ($132,000 for joint filers) in 2017 cannot claim it.5
That’s how the deduction ends up targeting upper-income graduate students. While graduate students would always obtain a larger benefit from the Lifetime Learning Credit, they cannot claim it if they earn more than $66,000 ($132,000 for joint filers). They can, however, claim the deduction until their earnings exceed $80,000 ($160,000 for joint filers). Thus a narrow band of graduate students, those earning between the income limits for the two benefits, are the only students who would claim the deduction. At those levels, their incomes are higher than the incomes of about 80 percent of U.S. households.6 Of course, tax filers can unintentionally claim a less generous benefit if they are eligible for more than one, such as an undergraduate claiming the deduction when she was eligible for the American Opportunity Tax Credit, which does happen.7
American Opportunity Tax Credit
Up to $2,500 (100% of first $2,000 in tuition and fees; 25% of next $2,000)
Full credit: up to $80,000 (single filers) or $160,000 (married filers)
Partial credit: up to $90,000 (single filers) or $180,000 (married filers)
Undergraduate students* enrolled at least half time (first four years only)
Lifetime Learning Tax Credit
Up to $2,000 (20% of first $10,000 in tuition and fees)
Full credit: up to $56,000 (single filers) or $112,000 (married ... By Jason Delisle
In an earlier Evidence Speaks post this year, Susan Dynarski and Judith Scott-Clayton summarized important research showing that federal tax benefits for college tuition have had no measurable impact on increasing college-going ... https://www.brookings.edu/blog/up-front/2018/05/25/6-ways-to-fix-the-tax-system-post-tcja/6 ways to fix the tax system post-TCJAhttp://webfeeds.brookings.edu/~/548070694/0/brookingsrss/topics/taxes~ways-to-fix-the-tax-system-postTCJA/
Fri, 25 May 2018 13:23:38 +0000https://www.brookings.edu/?p=518626

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By Benjamin H. Harris, Adam Looney

The Tax Cuts and Jobs Act of 2017 (TCJA) left many promises of tax reform unfilled. It put deficits and debt on an unsustainable trajectory, created uncertainty for individuals and businesses, and failed to simplify an overly complicated tax system. And though it will provide temporary economic stimulus, its effects on long-term economic growth will be meager—and its boost to Americans’ future living standards even smaller.

Ultimately, the TCJA punts real tax reform down the road. Facing an unstable fiscal situation, future lawmakers will have to act. Stabilizing the debt-to-GDP ratio at today’s level over the next 30 years would require herculean policy changes—some combination of permanent spending cuts or tax increases equal to 4.0 percent of GDP (Auerbach, Gale, and Krupkin 2018). Increases in revenues will be a necessary component of any plan to meet the nation’s fiscal challenges. So where should Congress go from here?

The good news is that our tax system is fixable. In a new paper published by the Urban-Brookings Tax Policy Center, we identify six ways future legislatures can raise revenue, reduce economic distortions, and promote economic growth. You can read a short summary of those strategies below. For more detail, download the full paper.

Ultimately, the TCJA punts real tax reform down the road.

1. Tax old capital and provide incentives for new investment.

If you’re an avid reader of economic literature on taxation (like we are), you know that many economists support reforms that tax “old capital”—that is, capital that is already committed—to finance lower rates on wages and new investment (implementing a consumption tax would be one, but not the only, way of doing this). Such reforms improve the prospects for both workers and active investors because they increase new investment, but without shifting the tax burden to workers. The TCJA does the opposite: it provides windfall gains to old capital, which not only presents a host of political and distributional challenges, but means the bill’s effects on growth are likely to be meager over the long run. As such, reversing the major components of the bill that produce these windfall gains can be an efficient way to raise revenue.

There are good arguments that the reduction in the corporate rate to 21 percent went too far. A corporate rate in the range of between 25 to 28 percent would keep the rate comparable to those in other developed economies and eliminate inefficient tax sheltering and tax avoidance behaviors that will arise when the rate on business income is below that on wages.

A related option is to eliminate the pass-through deduction. The reduced rate on pass-through business income reduces progressivity, picks winners among businesses, increases complexity, and exacerbates domestic distortions, all while cutting revenues.

Finally, lawmakers looking for ways to expand pro-growth elements can look to expand and make permanent TCJA’s provisions that allow companies to expense new investments and which simplify accounting rules for small businesses.

2. Fix the international tax system and limit provisions that facilitate corporate avoidance and income shifting.

The TCJA’s general approach to international taxation is conceptually sound, particularly if the U.S. is to remain locked into the basic corporate tax structure and tax base that has prevailed in the past. However, the plan does too little to reduce profit shifting, encourages a race to the bottom in international tax rates and norms, and retains incentives for U.S. companies to locate activities abroad. Several changes in the international tax regime could protect the U.S. tax base, reduce profit shifting, and raise revenue.

First, the special low rate on export income associated with intangibles (i.e., Foreign Derived Intangible Income) is unlikely to comply with World Trade Organization rules and may be designated an export subsidy. Moreover, there is little justification for the provision: it will be complicated, costly, and difficult to enforce— and there is little evidence similar approaches encourage innovation or influence locational choices. Other approaches, like the Research & Experimentation credit, are more efficacious ways to promote domestic innovation.

Second, the international minimum tax rate is too low, its base-narrowing allowance for foreign income from tangible investments is too generous, and the rules for applying foreign tax credits need repair. With a low rate and a narrow tax base, the incentive to locate certain activities in foreign jurisdictions rather than the U.S. is strengthened. Increasing the minimum tax rate to, say, 15 percent—net of 80 percent of foreign taxes paid—and reducing the tangible equity allowance from 10 percent to the rate applied to risk-free investments would reduce the ability and incentive to shift profits abroad to very low-tax jurisdictions. Rather than calculating the minimum tax based on the average tax paid across all foreign income, which allows companies operating in high-tax jurisdictions to benefit by booking more profits in tax havens to offset taxes paid elsewhere, the minimum tax could be applied on a country-by-country basis.

Third, while the corporate reform includes stronger rules to limit interest expense, key provisions that prevented multinational (or foreign-owned) corporations from loading up their U.S. subsidiaries with disproportionate amounts of interest expense were dropped at the last minute. As a result, foreign-owned firms—including inverted companies—retain a tax advantage over domestic firms. Along with stronger monitoring of transfer pricing, stronger limitations on interest expense would reduce erosion of the U.S. base.

3. Change the taxation of capital to promote more uniform taxation.

The TCJA exacerbated certain shareholder-level tax expenditures because of changes in corporate or pass-through taxes. For instance, lower rates on corporate and pass-through businesses and expensing provisions increase the costs of tax expenditures ranging from the exclusion of capital gains at death to tax-exempt savings vehicles. And tax rates on investments continue to face different effective and marginal tax rates depending on the type of account in which the investment is held, when the asset is sold, and how the investment is financed. These distortions reduce economic activity by shunting investments away from their most efficient uses.

Eliminating stepped-up basis (which allows someone inheriting capital investments to avoid paying capital gains taxes on gains accrued before the original owner’s death) and instead taxing capital gains at death or requiring carryover basis would be an equitable and efficient way to reduce the revenue loss from business-level tax cuts by shifting some of the tax burden to shareholders.

Another option for shifting the burden to shareholders from corporations would be to curtail a wide range of tax expenditures that allow corporate income to avoid tax. For instance, one approach is to strengthen anti-abuse rules for closely held stock in Roth IRAs, which allow IRA owners to shelter labor income by allowing an effective tax rate of zero on income from these assets.

Lastly, reform could subject tax-exempt organizations to tax on a larger share of their business profits. Tax-exempt organizations pay no tax on activities related to their exempt purpose. With a few exceptions, they also avoid tax on their investment income, including capital gains and dividends from corporations.

4. Reduce distortionary tax preferences in the individual tax code.

Any reform designed to maximize sustainable growth should address provisions of the tax code that incentive taxpayers to take actions that don’t have positive social benefits. Take, for example, the unlimited exclusion for employer-provided health insurance, which encourages a greater share of compensation to be delivered in the form of health insurance, rather than wages. This provision encourages overconsumption of health services, pushes up the cost of health insurance, and is estimated by the Joint Committee on Taxation to cost $155 billion in 2017 alone.

The Cadillac Tax, which imposes a surcharge on extremely expensive plans whose generosity exceeds a high threshold, is a judicious, effective, and incremental approach to addressing this distortion—it should be allowed to go into effect.

A wide variety of other tax expenditures are also good candidates for reform, ranging from changes in the mortgage interest deduction to incentivize homeownership, in retirement saving provisions to make them more effective and equitable, and in a wide array of smaller credits, deductions, and exclusions which could be consolidated, simplified, and more narrowly targeted.

5. Encourage working-age Americans to enter the labor force and supply more labor.

In designing a tax system, policymakers should be careful that programs and rules don’t impose artificial or inefficient barriers to employment. By reducing the marginal tax rate for many taxpayers in the near-term, the TCJA created incentives for existing workers to supply more labor (at least through 2025). But the approach was poorly designed to raise labor force participation or employment, and explicitly temporary, limiting its effectiveness.

Efficient options to encourage labor force participation include expanding the EITC to childless workers and to currently ineligible younger and older workers; providing tax relief for secondary earners to increase labor supply of married taxpayers; and legislating more generous benefits for child care to reduce the implicit tax on work for parents.

6. Improve compliance

Finally, taxpayers need help complying with the tax code and tax laws need to be enforced. Tax compliance is often measured in terms of the “tax gap,” which is the difference between taxes owed and taxes paid. Because of its size—it’s estimated to cost the U.S. government between $450 and $650 billion a year—even small, sustained reductions in the tax gap can contribute to deficit reduction.

Unfortunately, when it comes to tax compliance, there are no short cuts. Improvement requires a simpler tax system and more resources for the IRS to aid taxpayers and enforce the law.

The authors did not receive any financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are currently not an officer, director, or board member of any organization with an interest in this article

]]>
By Benjamin H. Harris, Adam Looney
The Tax Cuts and Jobs Act of 2017 (TCJA) left many promises of tax reform unfilled. It put deficits and debt on an unsustainable trajectory, created uncertainty for individuals and businesses, and failed to simplify an overly complicated tax system. And though it will provide temporary economic stimulus, its effects on long-term economic growth will be meager—and its boost to Americans’ future living standards even smaller.
Ultimately, the TCJA punts real tax reform down the road. Facing an unstable fiscal situation, future lawmakers will have to act. Stabilizing the debt-to-GDP ratio at today’s level over the next 30 years would require herculean policy changes—some combination of permanent spending cuts or tax increases equal to 4.0 percent of GDP (Auerbach, Gale, and Krupkin 2018). Increases in revenues will be a necessary component of any plan to meet the nation’s fiscal challenges. So where should Congress go from here?
The good news is that our tax system is fixable. In a new paper published by the Urban-Brookings Tax Policy Center, we identify six ways future legislatures can raise revenue, reduce economic distortions, and promote economic growth. You can read a short summary of those strategies below. For more detail, download the full paper.
Ultimately, the TCJA punts real tax reform down the road.
1. Tax old capital and provide incentives for new investment.
If you’re an avid reader of economic literature on taxation (like we are), you know that many economists support reforms that tax “old capital”—that is, capital that is already committed—to finance lower rates on wages and new investment (implementing a consumption tax would be one, but not the only, way of doing this). Such reforms improve the prospects for both workers and active investors because they increase new investment, but without shifting the tax burden to workers. The TCJA does the opposite: it provides windfall gains to old capital, which not only presents a host of political and distributional challenges, but means the bill’s effects on growth are likely to be meager over the long run. As such, reversing the major components of the bill that produce these windfall gains can be an efficient way to raise revenue.
There are good arguments that the reduction in the corporate rate to 21 percent went too far. A corporate rate in the range of between 25 to 28 percent would keep the rate comparable to those in other developed economies and eliminate inefficient tax sheltering and tax avoidance behaviors that will arise when the rate on business income is below that on wages.
A related option is to eliminate the pass-through deduction. The reduced rate on pass-through business income reduces progressivity, picks winners among businesses, increases complexity, and exacerbates domestic distortions, all while cutting revenues.
Finally, lawmakers looking for ways to expand pro-growth elements can look to expand and make permanent TCJA’s provisions that allow companies to expense new investments and which simplify accounting rules for small businesses.
2. Fix the international tax system and limit provisions that facilitate corporate avoidance and income shifting.
The TCJA’s general approach to international taxation is conceptually sound, particularly if the U.S. is to remain locked into the basic corporate tax structure and tax base that has prevailed in the past. However, the plan does too little to reduce profit shifting, encourages a race to the bottom in international tax rates and norms, and retains incentives for U.S. companies to locate activities abroad. Several changes in the international tax regime could protect the U.S. tax base, reduce profit shifting, and raise revenue.
First, the special low rate on export income associated with intangibles (i.e., Foreign Derived Intangible Income) is unlikely to ... By Benjamin H. Harris, Adam Looney
The Tax Cuts and Jobs Act of 2017 (TCJA) left many promises of tax reform unfilled. It put deficits and debt on an unsustainable trajectory, created uncertainty for individuals and businesses, and failed to ... https://www.brookings.edu/research/the-tax-cuts-and-jobs-act-was-a-missed-opportunity-to-establish-a-sustainable-tax-code/The Tax Cuts and Jobs Act was a missed opportunity to establish a sustainable tax codehttp://webfeeds.brookings.edu/~/547907666/0/brookingsrss/topics/taxes~The-Tax-Cuts-and-Jobs-Act-was-a-missed-opportunity-to-establish-a-sustainable-tax-code/
Thu, 24 May 2018 18:32:58 +0000https://www.brookings.edu/?post_type=research&p=518558

]]>
By Benjamin H. Harris, Adam Looney

The Tax Cuts and Jobs Act of 2017 (TCJA) leaves many promises of tax reform unfulfilled. The bill’s cost sets revenues far below projected spending levels, and puts deficits and debt on an unsustainable trajectory. Many provisions are temporary and expire, require clarification in regulation, or may not survive court challenges from our trading partners—creating uncertainty for individuals and businesses and punting hard choices to future policymakers.

While the bill provides temporary economic stimulus, it delivers only a meager boost to long-term economic growth, and even less for Americans’ future living standards. And it fails to achieve other goals of tax reform by making the tax system more complicated and more difficult to administer, while creating new opportunities for avoidance or noncompliance.

Fortunately, the flaws are fixable. In the 1980s, an ill-conceived deficit-burgeoning tax cut in 1981 was quickly revised in subsequent years, culminating in comprehensive reform in 1986. America would benefit if history repeated itself—and soon. When the time comes to revisit tax reform, policymakers will have the opportunity to install a tax code that is pro-growth, simpler, sustainable, and more equitable.

While the bill provides temporary economic stimulus, it delivers only a meager boost to long-term economic growth, and even less for Americans’ future living standards.

Tax old capital and provide incentives for new investment

Any new reform that provides windfall gains to already-committed capital must eventually offset those costs in ways that will stunt growth—such as higher taxes or more borrowing. That makes it difficult for any reform that increases the reward for old capital to be growth enhancing. As a starting point, that suggests that reversing or recapturing the TCJA’s windfalls should be a top priority.

Fix the international tax system and limit provisions that facilitate corporate avoidance and income shifting

The TCJA’s general approach to international tax reform is sound, particularly if the U.S. is to remain locked into the basic corporate tax structure and tax base that has prevailed in the past. However, the plan does too little to reduce profit shifting, encourages a race to the bottom in international tax rates and norms, and retains incentives for U.S. companies to locate activities abroad. A few practical improvements would greatly benefit the tax system.

Change the taxation of capital to promote more uniform taxation

While shareholder-level taxes were little changed in the TCJA, many pre-existing distortions are worsened by changes at the corporate or pass-through level. For instance, lower rates on corporate and pass-through businesses and expensing provisions exacerbate the costs of tax expenditures ranging from the exclusion of capital gains at death to tax-exempt savings vehicles. And tax rates on investments continue to face markedly different effective and marginal tax rates depending on the type of account in which the investment is held, when the asset is sold, and how the investment is financed. All of these distortions reduce economic activity by shunting investments away from their most efficient uses. Addressing these shortcomings is a critical component of any reform.

Reduce distortionary tax preferences in the individual tax code

The tax code creates a dizzying array of incentives that distort economic behavior. In some cases, the incentives improve efficiency by addressing an existing distortion or rewarding behavior with positive social benefits (“externalities”). Many of the distortions are minor, but some have profound implications on the U.S. economy. A reform designed to maximize sustainable growth should address, at very least, the most severe distortions.

Encourage working-age Americans to enter the labor force and supply more labor

Tax reform can also boost incomes by targeted reductions in marginal rates on earnings, especially for workers who have shown high responsiveness to lower rates. Reforms that lower effective marginal tax rates —which include the effects of both taxes and transfer programs— for low-wage, married, and older workers can increase both the number of workers in the labor force and the amount of hours worked.

Improve compliance

Due to its complexity and design, the current tax code creates both opportunities for avoidance and challenges for taxpayers seeking to comply with the law. . The cost of non-compliance is often measured in terms of the “tax gap,” which is the difference between taxes owed and taxes paid. Plausible estimates of the tax gap range from roughly $500 billion to $650 billion annually. Because of its massive size, even small, sustained reductions in the tax gap can substantially contribute to deficit reduction.

Conclusion

Congress should follow the example of past tax reform efforts and reverse the long-term damage done by the TCJA by implementing reform that will promote real, long-term growth.

The authors did not receive any financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are currently not an officer, director, or board member of any organization with an interest in this article

]]>
By Benjamin H. Harris, Adam Looney
The Tax Cuts and Jobs Act of 2017 (TCJA) leaves many promises of tax reform unfulfilled. The bill’s cost sets revenues far below projected spending levels, and puts deficits and debt on an unsustainable trajectory. Many provisions are temporary and expire, require clarification in regulation, or may not survive court challenges from our trading partners—creating uncertainty for individuals and businesses and punting hard choices to future policymakers.
While the bill provides temporary economic stimulus, it delivers only a meager boost to long-term economic growth, and even less for Americans’ future living standards. And it fails to achieve other goals of tax reform by making the tax system more complicated and more difficult to administer, while creating new opportunities for avoidance or noncompliance.
Fortunately, the flaws are fixable. In the 1980s, an ill-conceived deficit-burgeoning tax cut in 1981 was quickly revised in subsequent years, culminating in comprehensive reform in 1986. America would benefit if history repeated itself—and soon. When the time comes to revisit tax reform, policymakers will have the opportunity to install a tax code that is pro-growth, simpler, sustainable, and more equitable.
In “The Tax Cuts and Jobs Act: A Missed Opportunity to Establish a Sustainable Tax Code” (PDF), Benjamin Harris and Adam Looney look at six ways to improve the tax code when the time comes to amend or repeal the TCJA.
While the bill provides temporary economic stimulus, it delivers only a meager boost to long-term economic growth, and even less for Americans’ future living standards.
Tax old capital and provide incentives for new investment
Any new reform that provides windfall gains to already-committed capital must eventually offset those costs in ways that will stunt growth—such as higher taxes or more borrowing. That makes it difficult for any reform that increases the reward for old capital to be growth enhancing. As a starting point, that suggests that reversing or recapturing the TCJA’s windfalls should be a top priority.
Fix the international tax system and limit provisions that facilitate corporate avoidance and income shifting
The TCJA’s general approach to international tax reform is sound, particularly if the U.S. is to remain locked into the basic corporate tax structure and tax base that has prevailed in the past. However, the plan does too little to reduce profit shifting, encourages a race to the bottom in international tax rates and norms, and retains incentives for U.S. companies to locate activities abroad. A few practical improvements would greatly benefit the tax system.
Change the taxation of capital to promote more uniform taxation
While shareholder-level taxes were little changed in the TCJA, many pre-existing distortions are worsened by changes at the corporate or pass-through level. For instance, lower rates on corporate and pass-through businesses and expensing provisions exacerbate the costs of tax expenditures ranging from the exclusion of capital gains at death to tax-exempt savings vehicles. And tax rates on investments continue to face markedly different effective and marginal tax rates depending on the type of account in which the investment is held, when the asset is sold, and how the investment is financed. All of these distortions reduce economic activity by shunting investments away from their most efficient uses. Addressing these shortcomings is a critical component of any reform.
Reduce distortionary tax preferences in the individual tax code
The tax code creates a dizzying array of incentives that distort economic behavior. In some cases, the incentives improve efficiency by addressing an existing distortion or rewarding behavior with positive social benefits (“externalities”). Many of the distortions are minor, but some have ... By Benjamin H. Harris, Adam Looney
The Tax Cuts and Jobs Act of 2017 (TCJA) leaves many promises of tax reform unfulfilled. The bill’s cost sets revenues far below projected spending levels, and puts deficits and debt on an unsustainable ... https://www.brookings.edu/blog/up-front/2018/05/10/cbo-estimates-imply-that-tcja-will-boost-incomes-for-foreign-investors-but-not-for-americans/CBO estimates imply that TCJA will boost incomes for foreign investors but not for Americanshttp://webfeeds.brookings.edu/~/544822002/0/brookingsrss/topics/taxes~CBO-estimates-imply-that-TCJA-will-boost-incomes-for-foreign-investors-but-not-for-Americans/
Thu, 10 May 2018 14:57:12 +0000https://www.brookings.edu/?p=515894

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By Benjamin R. Page, William G. Gale

Proponents of the Tax Cut and Jobs Act (TCJA) claimed it would boost the U.S. economy and generate higher incomes for the American people. At first glance, recent estimates from the Congressional Budget Office (CBO) appear to support that argument. But the CBO analysis includes a subtle, yet extremely important difference: Foreign investors will end up receiving much of the gains and the net income available to Americans will rise barely, if at all.

The CBO analysis implies that TCJA effectively will have no impact U.S. incomes after 10 years. The difference, in econ-speak, is between the estimated effect on Gross Domestic Product (GDP, or the output created within in the U.S.), the effect on Gross National Product (GNP, output created by American workers and American-owned capital), and ultimately on Net National Product (NNP, which is GNP minus depreciation of capital goods, and comes closest of the three measures to American incomes). Hang on while we explain the difference.

CBO estimates that TCJA will increase U.S. GDP by 0.5 percent in 2028. CBO projects that the tax cuts will boost output in 2028 largely because lower tax rates on capital income—such as the 21 percent rate on corporate profits—increases the after-tax rate of return which in turn will boost the stock of productive capital such as computers or factories.

But here’s the kicker: CBO figures that most of that additional capital will be financed by foreigners—for example, from overseas corporations building factories in the U.S., or foreign investors buying U.S. stocks and bonds. As a result, net payments of profits, dividends, and interest to foreigners also will rise. Unlike GDP, the GNP subtracts those net payments to foreigners from domestic production. GNP therefore provides a better measure of the impact on U.S. incomes. CBO projects that tax bill will boost GNP by just 0.1 percent in 2028.

But GNP tells only part of the story. Because the increase in output stems mostly from additional investment in capital goods, the nation’s capital stock will be higher relative to output. That’s good because it can raise worker productivity and wages, on average. But to maintain that larger capital stock a larger share of output must be devoted to offsetting depreciation—the wear and tear on those additional capital goods.

It turns out that the rise in depreciation is about 0.1 percent of output in 2028—enough to erase the already meager boost to GNP. Thus, long-run incomes for Americans as measured by NNP will be more or less unchanged by the TCJA. You can email one of us at bpage@urban.org if you’d like to see the details.

And that’s the good news about the TCJA. It ignores the negative effects of the tax law: Worsening income inequality, less revenue to finance government services and benefits, and higher federal debt. If the tax cut’s direct benefits on U.S. incomes are non-existent, it is hard to make a case that it is a positive for the U.S. economy in the long term.

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By Benjamin R. Page, William G. Gale
Proponents of the Tax Cut and Jobs Act (TCJA) claimed it would boost the U.S. economy and generate higher incomes for the American people. At first glance, recent estimates from the Congressional Budget Office (CBO) appear to support that argument. But the CBO analysis includes a subtle, yet extremely important difference: Foreign investors will end up receiving much of the gains and the net income available to Americans will rise barely, if at all.
The CBO analysis implies that TCJA effectively will have no impact U.S. incomes after 10 years. The difference, in econ-speak, is between the estimated effect on Gross Domestic Product (GDP, or the output created within in the U.S.), the effect on Gross National Product (GNP, output created by American workers and American-owned capital), and ultimately on Net National Product (NNP, which is GNP minus depreciation of capital goods, and comes closest of the three measures to American incomes). Hang on while we explain the difference.
CBO estimates that TCJA will increase U.S. GDP by 0.5 percent in 2028. CBO projects that the tax cuts will boost output in 2028 largely because lower tax rates on capital income—such as the 21 percent rate on corporate profits—increases the after-tax rate of return which in turn will boost the stock of productive capital such as computers or factories.
But here’s the kicker: CBO figures that most of that additional capital will be financed by foreigners—for example, from overseas corporations building factories in the U.S., or foreign investors buying U.S. stocks and bonds. As a result, net payments of profits, dividends, and interest to foreigners also will rise. Unlike GDP, the GNP subtracts those net payments to foreigners from domestic production. GNP therefore provides a better measure of the impact on U.S. incomes. CBO projects that tax bill will boost GNP by just 0.1 percent in 2028.
But GNP tells only part of the story. Because the increase in output stems mostly from additional investment in capital goods, the nation’s capital stock will be higher relative to output. That’s good because it can raise worker productivity and wages, on average. But to maintain that larger capital stock a larger share of output must be devoted to offsetting depreciation—the wear and tear on those additional capital goods.
It turns out that the rise in depreciation is about 0.1 percent of output in 2028—enough to erase the already meager boost to GNP. Thus, long-run incomes for Americans as measured by NNP will be more or less unchanged by the TCJA. You can email one of us at bpage@urban.org if you’d like to see the details.
And that’s the good news about the TCJA. It ignores the negative effects of the tax law: Worsening income inequality, less revenue to finance government services and benefits, and higher federal debt. If the tax cut’s direct benefits on U.S. incomes are non-existent, it is hard to make a case that it is a positive for the U.S. economy in the long term. By Benjamin R. Page, William G. Gale
Proponents of the Tax Cut and Jobs Act (TCJA) claimed it would boost the U.S. economy and generate higher incomes for the American people. At first glance, recent estimates https://www.brookings.edu/research/the-tax-benefits-for-education-dont-increase-education/The tax benefits for education don’t increase educationhttp://webfeeds.brookings.edu/~/541671590/0/brookingsrss/topics/taxes~The-tax-benefits-for-education-dont-increase-education/
Thu, 26 Apr 2018 09:00:59 +0000https://www.brookings.edu/?post_type=research&p=512826

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By Susan M. Dynarski, Judith Scott-Clayton

Tax season ended last week. Taxpayers have filed for over $30 billion in credits and deductions for college expenses they paid in 2017.

Evidence now clearly shows that these credits have zero effect on college attendance. The tax credits surely make those who get them better off, but they do nothing to increase education. If their intent is to increase schooling, they are a failure.

The tax subsidies for education are now extensive, complicated, and expensive. The tax system subsidizes the families of college students through tax-advantaged savings plans, credits, a deduction for tuition costs and loan interest, an exclusion of scholarships, grants and tuition reductions from taxable income, and a dependent exemption for students aged 19 to 23. Finally, the tax code subsidizes college with a deduction for interest paid on student loans.

Economists George Bulman and Caroline Hoxby scoured hundreds of millions of tax returns searching for an effect of the tax credits and tuition deduction on educational outcomes.1 They inspected anonymized, detailed, individual-level administrative data from the IRS on the population of potential tax filers. The IRS has developed secure mechanisms that allow these data to be analyzed without compromising the privacy of taxpayers.

Bulman and Hoxby exploit the complicated rules that define eligibility for tax credits to estimate their effects. The tax credits “phase-out” within certain income ranges, with their value dropping with each additional dollar of income. The American Opportunity Tax Credit is worth up to $2,500 per student, but above an adjusted gross income of $160,000 (for a married couple) the credit drops steadily, until it reaches zero at $180,000.

Tax credits are supposed to increase attendance by offsetting some of the costs that students and their families incur by going to college. If tax credits work as intended, the association between level of family income and college attendance should weaken where the tax credits phase out. In the phase-out region, rising income is offset by the decreasing credit, so college attendance should be negatively affected to the extent that it is positively affected by the tax credit in the first place. Statistical analysts call this method a “regression-kink design”. “Kink” refers to the change in the slope of the curve representing the correlation between two variables (in this case, family income and college attendance) that one should see in the portion of curve where the hypothesized causal intervention (in this case, the phase out of the tax credit) is operative.

In many applications, small data sets make it challenging to precisely identify such a kink in the data. But with millions of observations at their disposal, the authors are able to conclusively reject any effect of the tax credits. In other words, there were no kinks in enrollment at the point that tax credits fade-out.

In another paper, Bulman and Hoxby use a regression-discontinuity design to estimate the effects of the tuition tax deduction for families around the maximum income cutoff for eligibility.2 Again, they find no evidence that the deduction increases college enrollment. They also find no effect of the deduction on enrollment intensity, college choice, tuition paid, or student debt.⁠

Why no effect? Tax credits and deductions primarily go to middle- and upper-income families, whose decision on whether to send their kids to college is unlikely to be affected by a tax benefit that is relatively small in relation to their income or the costs of college attendance.

Another possible explanation is that the credits are delivered too late to affect enrollment. Families get their tax refunds well after tuition is due; a family who pays tuition in September won’t get a tax credit until at least the following January. At that point the credit is a nice windfall but has arrived too late to help with paying the tuition bills.

The complexity of the tax benefits also likely undermines their effect. We discuss this in greater detail in a paper that provides a comprehensive overview of the tax benefits for education.3

An alternative way of looking at tax benefits for education is that they are a transfer program for middle-income families, putting more money in their pockets for all manner of expenditures, not just the costs of college. But they are ill-designed for that purpose, since they impose extensive administrative burdens on households, colleges and government. Reducing the tax rates applied to these families would be a more transparent and less expensive approach to achieving this goal.

If the billions spent on the tax benefits are to have any effect on college attendance, they should be delivered when tuition bills are due. One proposal, suggested by Hoxby and Bulman, is to compute eligibility for the credits automatically, using income tax information when a dependent approaches college age. Families could then be proactively notified of their eligibility. The authors also suggest that colleges file to receive the benefits directly from the IRS, so that a student need only present evidence of eligibility in order to have their account credited immediately.

An even more comprehensive approach would be to consolidate the tax credits with the Pell Grant, creating a single grant program that pays college costs at the time of enrollment. Eligibility could automatically be calculated using tax data, with funds delivered by the Department of Education. Families could apply by checking off a box on their tax forms. This approach would cut back substantially on paperwork, a relief for the millions of students who complete both the 1040 and the Free Application for Federal Student Aid in order to get federal grants, loans and tax credits for college.

Streamlining the tax benefits for education could potentially enhance their efficiency. At a minimum, a simpler system of education tax benefits would decrease the administrative and time costs of transferring funds to households with postsecondary expenses. At best, simplification would clarify incentives and increase investments in human capital.

The authors did not receive any financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are currently not an officer, director, or board member of any organization with an interest in this article.

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By Susan M. Dynarski, Judith Scott-Clayton
Tax season ended last week. Taxpayers have filed for over $30 billion in credits and deductions for college expenses they paid in 2017.
Evidence now clearly shows that these credits have zero effect on college attendance. The tax credits surely make those who get them better off, but they do nothing to increase education. If their intent is to increase schooling, they are a failure.
The tax subsidies for education are now extensive, complicated, and expensive. The tax system subsidizes the families of college students through tax-advantaged savings plans, credits, a deduction for tuition costs and loan interest, an exclusion of scholarships, grants and tuition reductions from taxable income, and a dependent exemption for students aged 19 to 23. Finally, the tax code subsidizes college with a deduction for interest paid on student loans.
Economists George Bulman and Caroline Hoxby scoured hundreds of millions of tax returns searching for an effect of the tax credits and tuition deduction on educational outcomes.1 They inspected anonymized, detailed, individual-level administrative data from the IRS on the population of potential tax filers. The IRS has developed secure mechanisms that allow these data to be analyzed without compromising the privacy of taxpayers.
Bulman and Hoxby exploit the complicated rules that define eligibility for tax credits to estimate their effects. The tax credits “phase-out” within certain income ranges, with their value dropping with each additional dollar of income. The American Opportunity Tax Credit is worth up to $2,500 per student, but above an adjusted gross income of $160,000 (for a married couple) the credit drops steadily, until it reaches zero at $180,000.
Tax credits are supposed to increase attendance by offsetting some of the costs that students and their families incur by going to college. If tax credits work as intended, the association between level of family income and college attendance should weaken where the tax credits phase out. In the phase-out region, rising income is offset by the decreasing credit, so college attendance should be negatively affected to the extent that it is positively affected by the tax credit in the first place. Statistical analysts call this method a “regression-kink design”. “Kink” refers to the change in the slope of the curve representing the correlation between two variables (in this case, family income and college attendance) that one should see in the portion of curve where the hypothesized causal intervention (in this case, the phase out of the tax credit) is operative.
In many applications, small data sets make it challenging to precisely identify such a kink in the data. But with millions of observations at their disposal, the authors are able to conclusively reject any effect of the tax credits. In other words, there were no kinks in enrollment at the point that tax credits fade-out.
In another paper, Bulman and Hoxby use a regression-discontinuity design to estimate the effects of the tuition tax deduction for families around the maximum income cutoff for eligibility.2 Again, they find no evidence that the deduction increases college enrollment. They also find no effect of the deduction on enrollment intensity, college choice, tuition paid, or student debt.⁠
Why no effect? Tax credits and deductions primarily go to middle- and upper-income families, whose decision on whether to send their kids to college is unlikely to be affected by a tax benefit that is relatively small in relation to their income or the costs of college attendance.
Another possible explanation is that the credits are delivered too late to affect enrollment. Families get their tax refunds well after tuition is due; a family who pays tuition in September won’t get a tax credit until at least the following January. At that point the credit is a nice ... By Susan M. Dynarski, Judith Scott-Clayton
Tax season ended last week. Taxpayers have filed for over $30 billion in credits and deductions for college expenses they paid in 2017.
Evidence now clearly shows that these credits have zero effect on ...